Investing in Gold and The Fed

Concerns about the economic outlook and the Dovish Fed fueled a gold price rally in 1-H of Y 2019. Triggering interest in gold investing and gold stocks.

The Big Q: Is the party is over or taking a pause to refresh?

Note: The Fed came through with a quarter-point rate cut on 31 July. The .DXY rose to 2-year highs.

The Big A: Gold stocks are usually stock market laggards when the outlook for the US economy and the USD is solid.

Institutional investors like gold as a hedge against uncertain times, as gold has proved its ability to hold value over centuries.

Here are some Key things to consider when deciding when, whether and how to invest in gold, either via gold stocks, such as Kirkland Lake Gold (KL), Barrick Gold (GOLD) and Newmont Goldcorp (NEM), or gold ETFs like GLD.

Gold stocks and gold ETFs are the simplest way for individual investors to bet on a rising gold price.

Investing in gold stocks can be a riskier, but also potentially more rewarding, way of investing in the precious Yellow metal.

Investors have 3 major options.

They can buy gold stocks individually.

They can buy an ETF that tracks the gold-mining stock sector, such as the VanEck Vectors Gold Miners ETF (GDX).

They can get direct exposure to the precious metal itself via the SPDR Gold Shares ETF(GLD).

In a sense, investing in gold stocks or a gold-mining ETF is a leveraged bet that the price of gold will keep rising. That is because a higher gold price can have a dramatic impact on the profitability of gold miners.

For example: Newmont said its total cost of production amounted to $907 oz of gold in Q-1 of Y 2019. That meant increases in the price of gold above that mark goes straight to the bottom line.

Corporate leverage works both ways: Falling gold prices can shrink the bottom line fast.

Investing in gold-mining stocks, especially a specific stock, brings in more complications than investing in the precious metal itself. The companies can suffer accidents or production snafus, deplete their reserves or pile up debt.

Adjusted for inflation, the price of gold hit an all-time high in early 1980 amid double-digit inflation in the US. Unadjusted for inflation, the gold price peak above $1,900 oz came in August 2011, in the wake of the great financial crisis. The Fed was engaged in its 2nd round of QE, the 2-year Treasury yield hit historic lows below 0.2%, and .DXY was not far off historic lows.

The gold price low of recent decades was just above $250 oz in Y 1999. That came as the US economy was still enjoying the Northside of the dot-com bubble and productivity was booming.

The common thread linking gold price highs and lows seems to be real interest rates. In Y’s 1980 and 2011, real interest rates were negative, with 2-year Treasury yields well below the rate of inflation.

In Y 1999, as the price of gold slumped, real interest rates were on the rise. The Fed was in a rate-hiking cycle, raising its benchmark rate north of 5%, well above roughly 2% inflation.

Gold is a store of value, and holding it comes with an opportunity cost. That money could instead be invested safely in US Treasuries. So, if real interest rates are attractive, holding gold is much less attractive. When real interest rates turn negative, holding gold is often a winner.

But real interest rates are not the only determinant of the price of gold. The supply-demand balance is among other important factors.

Consider, from the gold price bottom in late Y 2015 through June 2019, the SPDR Gold Shares ETF tracking the commodity’s price rose 31%, and the VanEck Vectors Gold Miners ETF rose 93% over the same frame.

That reflects the dramatic corporate earnings improvement thanks to the higher price of gold. Improved earnings, in turn, allow mining companies to increase dividends as the price of gold rises.

But, the fall for gold mining stocks from the Y 2011 price high was much rougher than for the precious Yellow metal. To the bottom in late Y 2015, the gold-tracking ETF tumbled 46%, but the ETF tracking gold miners dove to close off 80%.

The drop in real interest rates due to the reversal from the Fed largely explained the rise in the price of gold in late Y 2018 and 1-H of Y 2019.

The strength of USD also may have an impact on gold prices. Since it’s priced in dollars, gold will tend to rise if USD weakens against international currencies. Lately, USD strength has been neutral to negative for gold prices, but the USD could fall if the US economy slows.

Some of us see gold as a good long-term investment due to the US debt dynamics.

Spiraling federal deficits and surging debt levels could force the Fed’s hand. In other words, the Fed might have to keep interest rates low or monetize the debt to avoid a fiscal crisis. That could erode the USD’s role as the world’s reserve currency.

So, it makes to have gold stocks or an ETF tracking gold or gold stocks, in a balanced portfolio. And buy them in the same way as stock. Do your homework.

Paul Ebeling

Paul A. Ebeling, polymath, excels in diverse fields of knowledge. Pattern Recognition Analyst in Equities, Commodities and Foreign Exchange and author of “The Red Roadmaster’s Technical Report” on the US Major Market Indices™, a highly regarded, weekly financial market letter, he is also a philosopher, issuing insights on a wide range of subjects to a following of over 250,000 cohorts. An international audience of opinion makers, business leaders, and global organizations recognizes Ebeling as an expert.